03 Sep How to Cover Payroll When Cash Flow Is Low
One of the most important promises that small business owners make is to pay their employees on time. Covering payroll may not always be simple, but it’s vital to the business’s well-being because employees who get paid late don’t stick around.
However, when cash flow is low or irregular, you’re bound to have trouble issuing funds on time. How can you avoid stiffing your staff or defaulting on your other financial obligations when the people who owe you don’t pay on time?
This is where exploring forms of short-term financing comes in handy, and there are a number of different lending options.
How can financing help me cover payroll?
There are a few different reasons why your cash flow might be low, even if business is going well. Your customers may not be paying your invoices in a timely fashion, or you might have made a bulk purchase on materials for inventory.
There are times when your business cash flow will be low, and that’s okay—it’s a part of running your business. You can make adjustments to your business model by offering early payment discounts to your clients or building up a cash reserve to help you deal with unexpected cash flow issues.
But suppose you find that you are continually skirting the line between positive and negative cash flow or constantly running in the red. In that case, it’s time to either drastically cut costs or explore your financing options.
Cutting costs where you can should be your first step, but when covering payroll is at risk, you may need to look into adding some additional funds in the form of a business loan.
What are your financing options?
- A business line of credit
A line of credit is a revolving pool of funds that a business can draw on as needed. Though similar to credit cards, credit lines typically have larger spending limits, lower annual percentage rates (APRs), and access to cash.
If you often find yourself dealing with cash flow problems that affect not just payroll but other expenses, a line of credit is an excellent choice. You can usually use your funds for whatever you need—they won’t be explicitly earmarked for payroll. And you only pay interest on what you’ve withdrawn.
The main downside is that you need to establish your credibility as a business, demonstrating a history of steady revenue, offering paperwork, and potentially even advancing collateral to secure the deal.
- Invoice financing or factoring
If you have a new business, less-than-stellar credit, and find that unpaid invoices are your largest source of cash flow irregularity. In that case, invoice financing can be a more obtainable option than a line of credit or term loan.
When you finance an invoice, lenders give you about 85% of the total invoice, holding the other 15% until your client pays up—minus a fee for their services, which can vary based on how long your client waited to pay. No additional collateral is needed: Your invoice secures the loan.
The downsides of this option are that it’s usually more expensive than a standard loan and that the fees will depend on how long it takes for the invoice to be paid, which can prove to be quite costly.
- Payroll financing
Payroll financing is a short-term, unsecured loan specifically for payroll. It is essentially a Line of Credit that businesses can draw against to cover payroll, and like a line of credit, you only pay interest on what you’ve withdrawn. At the same time, it is easier to qualify for than a Line of Credit or Invoice factoring.
When processing payroll, businesses can draw funds not exceeding the net cash requirement for that particular payroll run.
The downside of this option is that it can only be used for payroll and is very short term; some lenders require it to be repaid in 30 days.
Ideally, every business should get a Line of Credit; it is the cheapest and most convenient option. However, not every company has the credit history for a line of credit. If you find yourself in a cash flow crunch occasionally and need a temporary infusion of funds to smooth things over, payroll financing is your best option. But if you need the money for a more extended period or find yourself constantly running thin on cash flow due to outstanding invoices, invoice financing is probably what you need.
A final word
In a perfect world, you’d never be in a position where you choose between compensating your employees or yourself or paying off your utility bill or your suppliers. Small business owners know how difficult balancing cash flow can be and how often these issues arise. If outside financing helps you cover these costs while keeping your employees happy and your business healthy, it’s worth seeing what options make sense for you.